3.3 Revenue, costs and profits

Revenue

Total revenue = Quantity sold x price

OR Average revenue x output

Average revenue = Total revenue / quantity

Marginal revenue = Change in TR / Change in Quantity - the change in a firms revenue from selling one extra unit of output

Maximising revenue occurs when MR = 0

Elasticity

When demand is price inelastic then a price rise will mean a business will increase their total revenue as the fall in QD will be less than proportional to the rise in price

A price reduction in a product with high elasticity of demand will increase TR

When PED is unitary then TR will remain unchanged

Price maker = a firm with the ability to alter prices due to market power

  • MR is less than AR because to sell additional units the price of all units must be lowered

Price taker = A firm with no market power, selling as the market price only

  • MR = AR because every unit sold is at the exact same price

  • TR is upward sloping with a constant gradient

Costs

Short run = a period of time where at least one factor of production is fixed

Long Run = All factors of production are variable

Fixed costs = Costs that do not directly vary with output i.e. rent, salaries and interest on loans

Variable Costs = Costs that do directly vary with output i.e. wages, utility bills, raw material costs

Total Fixed Costs

Short Run Cost and It's Types (With Diagram)

Average Fixed Costs - TFC / Q - AFC decreases with output so downwards sloping

Average variable costs - U shaped - at lower output levels output rises faster than TVC and at higher output levels rises slower than TVC

Average total costs = AFC + AVC

Short Run Average Costs: Marginal Cost, AFC, AVC, Formulas, etc

Marginal and Fixed Costs ( Short Run )

  • MC = the total change in total costs when output increases by one unit

  • Calculated by the change in costs / Change in output

The law of diminishing returns:

  • States that as more units of variable factors are added to fixed FoP output will rise at first then fall

  • This is because capital becomes more scarce and marginal product ( change in output from one extra worker ) falls causing MC to rise

  • The law of diminishing returns causes a fall in marginal product of labour

  • This causes average product to fall

  • Which then causes AVC and MC to rise

Long Run Average Costs

Assume that all FoP are variable

Long Run Costs - BeOne

Economies of scale = % output > % input

Constant costs = % output = % input

Diseconomies of scale = % output < % input

Shutdown point

  • In the short run firms will continue to produce output so long as price per unit is equal to or greater than AVC

  • Price = Min AVC = shut down point in a competitive market

In the Long Run a business needs to make atleast normal profit this is where just enough is made to keep FoP in their current use

  • Firms may be able to survive whilst making a loss due to profit saticficing or just an economic downturn i.e. travel in the pandemic - this may be cross subsidised in other areas